Examining The Advantages of LLC Businesses In A Tax Law Context
For first-time business owners, determining what type of business entity structure to go with can seem like quite a daunting task.
One of the most commonly seen options is a Limited Liability Company (LLC) which allows starting business owners to enjoy some of the structural and managerial benefits of a sole proprietorship whilst maintaining a plethora of tax advantages that have (traditionally) been exclusive to corporations.
Whilst there are many reasons to choose an LLC structure for your business, below we will take a look at the ample benefits that persist in a tax-law context.
How An LLC Business Pays Income Taxes
The Internal Revenue Service (IRS) has not yet developed a specific tax category for LLCs- likely because of their rather ‘’young’’ nature in comparison to other business entities.
This means that they can generally use the tax categories of corporations, sole proprietorships, or general partnerships- depending on their specificities and industry.
Single-member LLCs, for example, are (by default) taxed in an almost identical way to sole proprietorships, whereby they are disregarded as separate financial entities. This means that the single owner of an LLC is only required to report their business income by filing a Schedule C, which is included in the form 1040/1040-SR.
In cases where LLC businesses have more than one owner, they are taxed in a similar way to a general partnership. The tax return can be found on Form 1065, and each individual owner’s tax rate can be calculated using Schedule K-1.
Tax Advantages of LLCs
No Double Taxation
Unlike corporations, LLCs are not subject to double taxation- whereby a business pays corporate tax at a federal level, and then its shareholders pay income tax on a personal level for any dividends received.
LLC business owners enjoy a ‘’pass-through’’ taxation structure, meaning that any profits generated are funneled directly to the owners of the company, who solely pay tax at an individual level.
Certain Tax Deductions for Small Businesses
LLC owners can be privy to exclusive tax deductions that a corporation’s shareholders are not; these are known as Qualified Business Income (QBI) deductions, and they allow LLC business owners to attain tax deductions of up to 20% of their total business net income; this is supplementary to the ample existing ‘’standard’’ deductions.
May Avoid Corporate Franchise Tax
In a variety of U.S states, corporations are required to pay corporate franchise taxes; whilst this is not always the case, the majority of states do not require Limited Liability Companies to pay this tax.
Having said that, different tax-law requirements can (and do) vary significantly depending on a company’s home state, and so it is crucial to always stay up to date with your area’s relevant laws before launching your startup.
Potential Tax Disadvantages?
Having said that, an LLC business structure does come with a couple of potential disadvantages. One of the biggest ones is the fact that the owners of a Limited Liability Company are legally required to pay taxes on their ‘’distributive share’’ of the total profits of their company, even if they have not actually received any profits themselves.
This contrasts sharply with the situation enjoyed by the shareholders of a corporation who would not be required to personally pay income tax on any profit that wasn’t personally funelled directly to them (via dividends).
LLC owners can also face significant hardship when it comes to self-employment taxes; this is because, unlike the shareholders of a corporation- who are only legally required to pay half of the self-employment tax that their income demands (with their business paying the other half), owners of LLC companies need to pay both: the employee, and the employer portions by themselves.
Despite the several tax-related advantages that can be utilized via an LLC entity structure, the fact remains that business owners’ tax situations tend to change over time, and as their companies grow and become more reputable (and consequently more profitable), the ideal business structure for them will likely change (for example, from an unincorporated entity into a incorporated one).